by Kyle Conroy

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July 9, 2015

How One Small Toy Rolled Over Personal Liability Shields.

A primary reason for forming a limited liability company, corporation, or limited partnership is to avoid incurring personal liability for the debts or liabilities of the business. Take an LLC for example: when properly formed, an LLC, and not its owners, is primarily liable for the debts and liabilities of its business operations. Inherent protections afforded by an LLC include:

Protection from the LLC’s debts: An LLC will protect its owners from the LLC’s debts. Creditors can go after the LLC’s bank accounts and other property (with some exceptions). But none of members’ personal property can be touched.

Protection from the actions of the LLC’s co-owners or employees: By operating as an LLC, its owners are protected from personal liability for wrongdoing that is committed during the course of conducting business (however, someone who is directly involved with the matter could be personally liable for his/her wrongful actions and an LLC will not protect its owner from personal liability for their own negligence or other personal wrongdoing).

Protection from other members’ own personal debt: The property or money of an LLC cannot be taken by creditors of an LLC’s owner to meet the personal debts against the owner.

This separation of personal and entity liability is one of the main reasons to form and operate under a limited liability company. However, the principal legal theory of a recently concluded legal battle between the company Maxfield & Oberton and the Consumer Product Safety Commission (CPSC) seems to challenge some of these notions.

The Buckyball vs. The CPSC

Craig Zucker, owner of the company Maxfield & Oberton, a company with $18 million in annual sales, recently settled a lawsuit brought against his company by the CPSC.

The lawsuit centered on the once hot commodity desk toy, Buckyballs. Buckyballs are small, shiny magnets that can be arranged into shapes and were very popular in offices. Although Buckyballs was advertised as an adult gift toy, it soon caught the attention of children. Many children developed holes in their stomachs and intestines after swallowing the magnets. After several complaints, in marched the CPSC.

Despite Zucker’s efforts to cooperate with the CPSC for several years, it declared the balls and their warning labels “imminent hazards” and brought a lawsuit against Maxfield & Oberton. After a lengthy legal battle, Zucker decided to close his company, relying on his limited liability shield to protect him from the CPSC.

The CPSC pursued Zucker personally and accused him of dissolving his company to avoid liability. On May 9th, 2014, Zucker settled with the CPSC, for $375,000 as part of a recall of Buckyballs.

Legal Implications

Since Buckyballs was settled, it does not offer much in terms of legal precedent. However, it does pose the question: To what extent are owners of limited liability entities protected from third party claims?

Even if the CPSC had a valid claim against to the distributed assets of Maxfield & Oberton, the CPSC’s argument ultimately hinged on the Responsible Corporate Officer Doctrine. This doctrine holds responsible corporate officers liable for the actions of their corporation, even in the absence of personal guilt or proof of the defendants’ knowledge of or participation in the violation. Established in United States v. Dotterweich, the Responsible Corporate Officer Doctrine cannot take effect unless a corporate agent is standing in a position of responsibility and authority to prevent or to correct a legal violation and failed to do so. What is unusual about how the doctrine was used against Zucker is that previous cases have involved a clear violation of law by a corporate entity. In Zucker’s case, nothing illegal had occurred (this was even acknowledged by the CPSC). By determining that Buckyballs are an imminent hazard to children, the CPSC took a doctrine previously reserved for illegal conduct, and used it to pierce a company’s liability shield for a simple product liability suit.

The fact that Maxfield & Oberton’s personal liability shield failed to protect Zucker after dissolution is troubling. Many states (Missouri included) limit a third party claimants ability to recover against members of a dissolved LLC to recovering assets distributed to the member in liquidation. Thus, owners of product companies who previously relied on their LLC’s to take third party claims down in dissolution may not even have that option to rely on if the CPSC comes knocking.

Business owners in Zucker’s position should be cautious when entering the market. Strong warning labels should be on the product at all times throughout distribution and retail sales and products liability insurance should be maintained at all times. Carefully drafted terms of use may also limit exposure. In some cases, it may be preferable to postpone dissolution until after a final judgment is rendered, just to be sure all claims are resolved at the entity level.

Buckyball may be an abnormal case in the way the Responsible Corporate Officer Doctrine was applied. However, business owners should ensure that they have counsel throughout every stage of the product R&D and distribution process to avoid these types of situations.

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